April 20, 2020, will live in infamy for oil traders. At the start of trading that day, West Texas Intermediate (WTI), one of the main global oil benchmarks, opened at $17.85/barrel, an exceptionally low price. Then the bottom fell out of the market. For the first time ever, the price of oil dropped into negative numbers and by the end of the day, WTI was a negative $37.63/barrel. This means sellers had to pay buyers a hefty fee to take their oil.
Since then, the trend has been higher. On June 22, a barrel of crude was trading in the $74s, the highest price since 2018. This is a very impressive rebound, especially when considering that economies of many countries still haven’t returned to pre-pandemic levels.
So what happens next? Will oil give back recent gains or continue to rally? These questions are timely and the answers will affect investors, inflation, and businesses around the world.
Supply and demand always play an important role in determining price, and in this case some very informed sources are concerned there may not be adequate supply going forward.
“The level of drilling ...is insufficient and has been for a number of years to sustain oil production at current levels.” That’s the opinion of David Messler, an oilfield veteran who has held a variety of important positions in the industry and worked on six continents over the last 38 years. It doesn’t take a financial wizard to understand that if less oil is produced, its price could rise.
The oil industry is not a fun place to be these days, and it hasn’t been for some time. Environmentalists say fossil fuels should not be used because they may be the cause of climate change and certainly are exacerbating the problem. Literally every major automaker is either already producing EVs or has announced plans to do so - along with plans to phase out gas-powered vehicles. The growing use of solar and wind power also is cutting into business.
There are other problems the industry has to contend with, too. Some investors and funds want to invest only in “green” companies. And governments in the US and abroad are promoting policies to lessen the amount of oil being used.
As a result of these trends, many oil companies, including industry giants like Shell, ExxonMobil, and BP, have reduced their petroleum-related expenditures. Some have even shuttered petroleum facilities or converted them to produce renewable energy. A Dutch court recently ordered Shell “to speed up its de-carbonization.”
Is Change A Coming?
According to Messler, most people enjoy the benefits of adequate energy supplies without giving it a second thought, but he anticipates this will change.
“Soon the result of this key factor - a lack of new drilling - will become apparent, and people will wonder where all the easy and cheap energy went,” he says. “The lack of new drilling will start to show in a decline in production as early as next year. It will be a fairly shallow slope at first but will steepen as the ratio of older wells to newer wells increases. The result will be less oil being produced over time.”
At the same time, related factors also could impact production significantly. For example, because of the pandemic and the economic problems that ensued, equipment costing billions of dollars fell into disrepair and was sold for scrap metal. Many oil field employees were forced into new careers. And industry experts say production from some shale wells will decline because they were not maintained properly.
In addition, the number of oil rigs in service is way down. In 2013, an average of 3,400 rigs were spinning every day, but now this number is just 1,232. It is estimated that only one of every six barrels of oil used is being replaced.
These developments don’t mean a perfect storm is taking aim at the oil industry - but they do lend support to Messler’s concern about lower oil production ahead and the ramifications this might have. Other informed sources have reached very similar conclusions.
According to a BofA Global Research report, “The robust global oil demand recovery will outpace supply growth over the next 18 months, further draining inventories and setting the stage for higher oil prices.” BofA analysts estimate that the global market will be under-supplied by 900,000 barrels/day and forecasts that oil will reach $100/barrel in 2022.
The Nigerian National Oil Corporation said that “If international oil companies continue to curb their investments in new exploration and production, oil could soar to $200/barrel.”
And according to Rystad Energy, an energy research and business intelligence company, the proven oil and gas reserves of “Big Oil” are falling at an alarming rate, as the quantity of oil used is not being fully replaced with new discoveries.
Rystad says the proven reserves at Big Oil dropped by 13 billion barrels in 2020 and replacing that is becoming increasingly difficult, as investments in exploration decline and success rates in finding new deposits fall. And so far, it appears that 2021 will not reverse this trend. In the first quarter, the industry discovered just 1.2 billion barrels of oil and equivalent, the lowest amount since 2014.
In recent years, so much attention has been focused on the Green New Deal and its proposals - transitioning the economy to zero-emission energy sources, investing in electric vehicles, making infrastructure green - that it’s easy to get the impression that oil is no longer relevant.
But that would be a mistake. In fact, oil is still very crucial to economies around the world and will remain so for many years. Oilprice.com recently quoted the head of a commodities firm who predicted that oil could trade as low as $35 or as high as $130/barrel in the next few years.
Investors would do well to follow developments in the industry closely as events are unfolding rapidly and prices could change even faster. To whatever extent possible, no matter how little that may be, being prepared for change can only help.
Sources: www.eia.gov; www.globalriskinsights.com; www.oilprice.com; www.rystadenergy.com; www.oilprice.com; www.yahoofinance.com; www.zerohedge.com